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EMEA Morning Briefing: Stocks to Jump as Powell Quashes 3/4-Point Hikes Talk

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Opening Call:

European equities should track Wall Street's rally after Jerome Powell soothed investors' fears that the Fed might be considering bigger interest-rate increases in the coming months. In Asia, stocks were mostly higher; the dollar extended its retreat; Treasury yields steadied; and oil and gold gained.

Equities:

European shares are poised for a strong rebound Thursday after the Federal Reserve delivered the first 50-basis-point interest rate hike since 2000, but said larger increases weren't in play.

U.S. stocks were initially little moved by the Fed's policy decision but rallied after Jerome Powell answered the second question at his press conference. Asked whether future hikes could be even larger than 50 basis points, Powell was clear: "A 75 basis point increase is not something the committee is actively considering."

By the end of Powell's 47-minute press conference, stocks were up 2%. And by the close, the S&P 500 was up 2.99%, for its best day since May 18, 2020.

"It was a relief rally on the back of the 75s being taken off the table, " said Michael de Pass, global head of linear rates trading at Citadel Securities.

Economic Insight:

Fitch said the Fed's singular focus on fighting inflation is creating big risks for the U.S. outlook. The Fed is "engaged in a dash to get rates back to neutral territory by the end of this year," said Brian Coulton, chief economist at Fitch.

"With inflation pressures ongoing, the risk of monetary tightening prompting a significant growth slowdown or even recession in 2023 is growing," Coulton said.

Post-Fed Commentary:

The Fed may have raised rates by the largest degree in over 20 years, but it still ended up being somewhat dovish, said Alison Boxer, US economist at bond fund Pimco.

"The main news from the press conference was that Powell pushed back on the 75 basis point hikes that markets had started to price in." Jeff Klingelhofer, co-head of investments at Thornburg Investment Management, said "I was surprised to see a dovish statement slightly dismissive of inflation."

But others said Powell's firm guidance that more half percentage rate hikes are coming has an impact on the longer run outlook. Kathy Bostjancic of Oxford Economics said Powell's guidance "introduces upside risk to our call for a total of 200bps rate increases this year."

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Wells Fargo's Jay H. Bryson said the Fed is likely to raise rates again by 50 basis points in June unless "the economic outlook changes materially over the next six weeks."

After the next FOMC meeting, the pace of tightening will start to depend more on incoming data, he said. "We currently project that the FOMC will increase its target range for the fed funds rate by 25 bps at the July 26-27 meeting...But with the market fully priced for a 50 bps rate hike at that meeting, we acknowledge that the risks to our current outlook are skewed to the upside."

Forex:

The dollar remained under pressure in Asian trade after it tumbled Wednesday.

The FOMC's resolve to move policy to neutral as soon as possible summed up the dollar's strength, said SPI Asset Management's Stephen Innes. However, with Powell pushing back against a 75bps increase while acknowledging global risks, these were two triggers for dollar selling.

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Investors may be too optimistic about how far the Bank of England will raise interest rates and are overlooking risks facing the U.K. economy, leaving the pound vulnerable to further bouts of selling, analysts said. The BOE is fully expected to raise interest rates by 25 basis points to 1.0% in a decision Thursday.

Beyond that, its scope to raise rates will be limited as a cost of living crisis, caused by a combination of higher energy prices and the U.K.'s exit from the European Union, could restrict scope for further rate increases.

Read more here.

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The Norges Bank's next policy meeting is likely to be uneventful but the prospect of the central bank raising interest rates further should support the Norwegian krone over the longer run, said Bank of America.

The Norges Bank will probably leave rates on hold Thursday but continue to guide towards a 25 basis points rate rise in June, said BofA. "Further out, we expect the relative Norges Bank stance to support NOK."

The NOK should also receive a lift from higher oil prices if risk sentiment stabilizes, said BofA, which expects EUR/NOK to fall towards 9.50 from 9.9210 currently.

Bonds:

Treasury yields steadied in Asia after they fell Wednesday following Powell's comments. The 2-year yield, which is most closely tied to the Fed's near-term policy path, fell by the most since February.

A 75 basis point hike on Wednesday would have theoretically been "the right move" to combat inflation, said head trader John Farawell at Roosevelt & Cross, a bond underwriter in New York.

"There's no doubt about it, this is a nervous market with rates likely to climb from here. Watch the front end of the curve: We may see the curve flattening again" in weeks to come as traders position for the prospect of a bigger hike in June.

Post-Fed Commentary:

Just as the Fed could never offer much precision about what asset-buying stimulus did for the economy, so it goes for the effort to roll back central-bank holdings. "I would stress how uncertain the effect is of shrinking the balance sheet," Powell said Wednesday, addressing the effort to lower the size of the Fed's $9 trillion balance sheet, which starts on June 1.

That paired with the similarly hazy rhetoric offered by the Fed about what stimulus did when it was buying bonds, beyond vague comments about how the purchases ease financial conditions. Put another way, the Fed doesn't have a strong handle about what its asset-buying efforts do as part of making monetary policy.

Energy:

Crude futures added to gains in Asia, with their advance continuing to be driven by the European Union's proposed ban on Russian oil imports.

SPI's Stephen Innes said the market "should expect a downswing in Russian production that will tighten the global market, keeping a floor on prices for the near future."

Metals:

Gold added almost 2% in Asia, after prices ended Wednesday's regular U.S. session with a loss.

"The dollar index lost steam on the back of the Fed's decision and this has helped the gold price which has been oversold as some were thinking that the Fed may increase the interest rate by 75 basis points," said Naeem Aslam, chief market analyst at AvaTrade.

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Most base metals were higher, boosted by the weaker dollar and easing worries over aggressive Fed tightening.

However, much uncertainty remains due to Covid-19-related lockdowns in China, said ING. A slew of Chinese economic data, such as PMIs, have reinforced the demand destruction and bleak near-term outlook, ING added.

   
 
 

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